People, inherently, in most of the western civilization, spend a significant portion of their life and money on buying products and services. While fulfilling this purchasing “role”, they are identified as Consumers. The common, and logical, perception is that for a consumer to be able to purchase her/his desired goods or services, be it day to day needs, assets, presents, travel, etc., she/he is required to have the available financial means, namely “enough money in the bank”, or elsewhere.
Several consumption and purchasing mechanisms have been around, some going back to the dawn of history, allowing consumers to purchase goods and services without necessarily having the required funds at the time of purchase, rather using money they do not own to finance the purchase, and pay back at a later stage.
To name a few current such financing schemes:
Bank loans;
Mortgages;
Leasing (cars, etc.); and
Revolving credit card schemes: allowing consumers to pay their credit card expenses gradually (revolving them).
Obviously these financing methods, and others, do not come free of charge. Consumers are usually charged, on top of the purchase cost, financing fees by the institute or body providing the funds that enable the purchase.
It is quite often that such financing mechanisms are used even by consumers having enough immediate funds, but preferring to not spend them on the current purchase, thus controlling their cash flows, just like any business firm does.
Possible reasons for such behavior may include:
A future expense is expected and will require available funds;
The current purchase, for which a “loan” is taken, is about to exceed the consumer's periodical budget/salary;
Money is invested and cannot be used; and
Emotional/Psychological motivations (e.g.: financial security).
The financing solutions are provided by a variety of sources, some providing a general purpose loan, not linked to a specific purchase, and others link the “loan” to a specific purchase/product/service. For example:
General Purpose Financing:
Credit card issuers (revolving credit accounts, etc.);
Financial institutions: banks, etc. (loans); and
Installment loans.
Specific Financing:
Mortgage banks;
Car/other leasing companies; and
Merchants or service providers.
Revolving Credit Card Loans
The revolving instrument is a common worldwide credit card industry solution of general purpose loans. In the revolving method, a card holder can decide how much of his monthly credit card expenses he would rather revolve to the next month (within certain limitations).
The financing costs for such instrument are Annual Percent Rate (APR) derived from the national Federal interest rate. It is not fixed, and usually raises a lot above the Federal interest rate.
One reason for the high revolving APRs is the “risk” institutes (Credit card issuers/banks), providing such loans, take: A card holder can try avoiding some or all future payments, when in fact the product or service is already his/hers, in several ways:
Denying the purchase;
Closing the account; or
“Disappearing”.
Such cases “expose” the loaning institute to unplanned cost and thus loss of money.
The revolving mechanism is common in the US consumer credit market, due to the popularity of credit cards as a monetary instrument (over 150 million cards in the year 2006), where more than 60% of card holders are using revolving credit line on their cards.
Once a consumer has been approved for a credit line (usually pre approval), it is easy and immediate to use revolving mechanism for any purpose at any time, using his/her credit card. It is though, carrying one of the most expensive interest rates for consumers.
During 2006 the revolving system in the credit card industry at the US only had an outstanding of approximately US$826.6 Billion, compared to US$ 1,526.4 Billion in non revolving credit system (e.g.—loans) for consumer spending (excluding housing), most of which is not done through credit cards.
Americans are used to using non-revolving credit (mainly leasing or other periodical pay-back loans) for high value items such as cars, mobile homes, education, boats or vacations. These are usually financed by the manufacturers or financial institutions in fix monthly installments.
Leasing
Leasing loans are available in the US, but are mostly limited to specific high ticket purchases, such as cars, houses and boats, provided directly by the merchant and dedicated for the desired consumer product i.e. “specific purchase” loan.
In this case, the purchased product is registered as a grantee for the given loan. The APRs for such loans vary between industries and are usually lower than the APR of the revolving credit card APR's. This kind of credit loan is usually not preapproved as in the case of revolving credit card accounts.